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3 KPMG is proud to present this sixth annual survey of the Russian insurance market. You are invited to come with us as we explore the key directions in which the Russian insurance market is moving, and to look at the trends as seen by the chief executives of insurance companies that will determine short-term market development was a difficult and complicated year, full of events that heavily impacted all firms operating in the Russian insurance market. The economic aftershocks continue to echo across the insurance industry, causing market growth to progressively slow. Against this backdrop of unstable foreign exchange rates, CMTPL insurance legislative reforms caused a market redistribution between the large and medium companies. Our survey s participants forecast that smaller market players will, like the Top-11 to Top-20 companies, see decreases in sales. This is due to the unstable macroeconomic environment, the limited resources that smaller players can call upon, and the greater hurdles they face in raising additional capital. The expected loss ratios for Casco, CMTPL and VMI have increased when compared with last year s estimates. However, cost-cutting activities scheduled by insurers at the beginning of 2014 were effective, having prevented decreases in expected profitability for all lines of business, except Casco. We can thus conclude that the preventive measures taken to maintain the profitability of Casco are likely to have been insufficient. Changes made by the regulator to compulsory insurance have intensified regulatory pressure on companies in all market segments. Regulation can affect any player, irrespective of size, as recent insurance market events show. Nevertheless, our survey participants continue to believe that areas such as capital adequacy and insurance fraud still require regulatory control. We invite you to explore the findings of our survey and hope that this information will be enlightening for you. We would also like to take this opportunity to thank our colleagues and partners who contributed to this survey, and extend our gratitude to all the respondents, without whom this survey would not have been possible. Best regards, Adrian Quinton Partner, CIS Head of Insurance and Actuarial Services June

7 Despite the gross written premium of top firms increasing, total market growth is slowing down Companies in the Top-11 to Top-20 range appear to be the main reason why insurance market growth decelerated in These companies, as would be expected, focus on providing motor insurance and VMI. They therefore suffered from the political and economic events that occurred last year more than others, seeing their aggregate portfolios curtailed by 4%. The insurance CEOs who took part in this survey believe that this decline will spread to the smaller market players, bringing the entire market closer to stagnation. The main negative influences on the insurance market are coming from three sources: the economic situation in the country, purchasing power, and bank lending. However, our survey respondents expected CMTPL premiums to increase following a revision of rates, and this could become one of the few drivers of insurance market growth. Our respondents did not arrive at a definite conclusion as to how the life insurance market will develop, despite it showing double-digit growth over the last few years. Over half of our respondents are optimists, expecting the market to grow; while the remainder are more conservative, envisaging a decrease in gross written premium. Aiming to maintain the profitability of their businesses, top managers keep on cutting costs The economic shocks that have hit Russia in the last two years have complicated the tasks faced by chief executives in the insurance industry. The number one objective for an insurance company, as for any business in any other sector, is to increase profitability. In 2015, as previously, cost cutting is one of the principal ways that this goal can be achieved. However, practical methods to achieve this goal has changed. Now they include optimisation of tariff rate scales, taking into account currency market movements. Insurance companies have shifted focus to concentrate on retaining clients. Increased consumer loyalty leads to lower acquisition costs, as well as to the securing of current revenue levels. Insurers are trying to increase their appeal to loyal customers in different ways. Product line expansion enables existing customers interest to be aroused, stimulating them to purchase connected products. More detailed underwriting could lead to optimisation of the rates being offered in connection with popular products, making them cheaper for some consumers by allowing discounts to be awarded to loyal clients. June

8 Combined loss ratios for all lines of business, except Casco, will remain at 2014 levels The Casco loss ratio is more vulnerable to macroeconomic influences. Survey respondents expect the profitability of Casco insurance to decline in response to volatility on the currency markets. The expected profitability of CMTPL insurance will stay at previous years levels, most probably due to the activities of the regulator concerning this line of business. Regulatory control is likely to tighten. According to the predictions of our respondents, the combined loss ratios for other lines of business will not significantly differ from those ratios of previous years. The implementation in 2014 of cost optimisation measures is likely the most probable reason behind the maintenance of profitability. Decreasing or canceling salary indexations, rather than reducing the headcount, is assumed to be the chosen route to further cutting personnel costs. However, the threat of brain drain is likely to be critical for insurance companies, which will struggle to try and keep their existing human resources in the current economic environment. Studying the way in which relationships with intermediaries and partners can be optimised is a practical route to cutting administrative and acquisition costs. Renewing rent contracts using fixed Rouble exchange rates would appear to be the most effective way to cut costs. Top managers are also optimising the organisational structures in their companies and developing less costly sales channels. Insurers intend to reduce inflationary pressure on the profitability of motor insurance In order to fight against inflationary pressures on motor insurance, insurance chiefs are intending to hedge their exchange rate risks and increase their tariffs on foreign-made cars. Inflationary pressure affects CMTPL to a lesser extent following implementation of the unified methodology to determine recovery expenses. Nevertheless, a majority of survey respondents find current CMTPL rates to be insufficient. They believe that on average rates should be scaled-up by 15%. 8 Ongoing change: the Russian insurance market survey

9 Insurance companies could be underestimating the impact of fraud on their performance Survey respondents reported that the process of settling motor claims is subject to a far greater degree of insurance fraud. In the day when insurers can no longer maintain profitability by calling on the usual policy levers, it is likely to be those insurance executives who pay attention to fraud levels who find additional room for manoeuver and increase profitability. The impact of internal fraud on company revenues is estimated by our survey participants as insignificant, though they singled out procurement, underwriting, commission payments, and abandons disposal as possible internal fraud vulnerabilities. It might be that insurers are concentrating so much on external fraud, that in so doing they are potentially underestimating problems with their own internal fraud. CEOs of both large and small insurance companies note strengthening regulatory pressure The regulator monitors the activities of market players irrespective of their size, a fact verified by recent insurance market news. However, a quarter of survey respondents consider that the market still has areas where regulation needs significant improvements. One such area identified by our survey participants is capital adequacy. Some respondents consider the current capital requirements as economically groundless, and suggest transitioning to foreign practices. Survey respondents expect consolidation of the insurance market to speed-up Stronger regulatory pressure has resulted in an altogether tougher insurance market environment, bringing many companies closer to bankruptcy or to the point at which their licences may be revoked. The smaller the company, the greater the effect from the economic woes: smaller companies will be writing less premium, enabling larger firms to enlarge their market share. June

11 Measures which are likely to be taken by insurers given the macroeconomic situation in the country Decrease other operational costs 73% 100% Decrease personnel costs 67% 82% Change pricing 36% 50% Decrease cost of claims 36% 42% Decrease acquisition costs 42% 55% Develop sales in order to acquire a share of smaller companies 9% 33% Restructure portfolio profile towards more profitable products* 33% Change asset structure* 17% * This option was first presented in the 2015 questionnaire. To maintain the profitability of their businesses in the current macroeconomic climate, insurance executives are going to continue cutting costs. June

12 Rebounding from the political and economic events that took place in 2014, the Russian insurance market continues to change shape. Last year the majority of survey respondents singled out cuts to personnel costs as a number one target; now they are more focused on reducing operational expenses. Most insurance executives are going to continue cutting personnel costs, though to a lesser extent than previously. This might be as a result of actions in some companies to optimise employee benefits. Cutting wages simply carries the risk of prompting a brain drain of a firm s staff, while high inflation has led to the price of consumer goods increasing. Paying staff a wage insufficient to pay for consumer goods will simply lead to staff leaving. Exchange rate fluctuations have forced insurance companies to consider tariff revisions, particularly if their business is exposed to currency market volatility. Half of our respondents believe that it is time to implement rational tariff changes to enable them to retain their current market position and keep their financial stability. 12 Ongoing change: the Russian insurance market survey

13 Priority areas of development Increase profitability 75% 73% Increase retention level 36% 75% Reduce acquisition and administrative costs 67% 73% Develop new products and review the condition in current products 18% 58% Improve risk management, including actuarial function and underwriting 18% 58% Optimise distribution 42% 45% Increase portfolio volume 33% Maintain reputation 17% Change asset structure to increase investment profitability* 17% * This option was first presented in the 2015 questionnaire. As always, the key priority for insurers is to increase profitability, though the ways to achieving this goal have slightly changed. For 2015, our respondents, together with cutting acquisition and administration costs, have highlighted other objectives such as increasing customer retention levels by diversifying the products they offer, and optimising underwriting strategies. Insurers are seeking every opportunity to raise the effectiveness of their business. As identified in our 2014 survey, the majority of insurance firms keep focusing on retaining their current position and holding market share rather than increasing their portfolio. June

15 Gross written premium dynamics per market segment Inflation +6.5% +10.9% +9% CAGR for 2 years +11% 24% +12% 24% 24% 15% 14% 13% 0% 63% +12% 61% 61% Total market CAGR +10% Top-10 Top-11 to Top-20 Outside the Top-20 Note: Percentages may not add up to 100% due to rounding. Source: Central Bank of Russia. The economic and political events of the last two years have had a negative influence on the insurance market, causing a slowdown in its expansion. In 2013, the growth rate decreased by half 1, while in 2014 the macroeconomic environment affected the market to a much lesser degree, causing a slowdown of only 2%. In fact, in 2014 the market increased 9%, much higher than the 5.5% growth rate expected at the beginning of the year, but lower than inflation. 1 New reality: the Russian insurance market survey, KPMG 2014 June

16 The leaders on the insurance market are growing faster than the market s average rate of growth, indicating that the market is continuing to consolidate. Insurers had expected steady growth for the large and medium players, but in fact the Top-11 to Top-20 companies decreased the amount of gross premium written in their segment. The smaller market players maintained a consistent year-on-year market share. The reason for the redistribution between the large and medium companies was probably the 8% decrease in CMTPL sales experienced by the Top-11 to Top-20 players, which are mainly specialised in providing motor insurance in the regions. The reduction in CMTPL sales in this segment was mainly caused by the following: MSK ceasing to sell in regions where it was making a loss 2 ; GUTA-Strakhovanie curtailed its business for the period of sanation 3. Despite the crisis, smaller companies were able to keep their market share. This was most probably due to the structure of their portfolios, mostly oriented at life insurance and property insurance, both of which showed double-digit growth in Smaller companies usually offer cheaper insurance, which is attractive for customers in difficult economic times. Top-10 Russian insurers by gross written premium in 2014 (RUB bln) Market share Change in market share from 2013 Rosgosstrakh ,4% 2,2% SOGAZ ,9% 1,2% Ingosstrakh 70 7,0% 0,7% RESO-Garantia 65 6,6% 0,3% AlfaStrakhovanie 58 5,9% 0,2% VSK 38 3,8% 0,4% VTB Strakhovanie 37 3,7% 0,3% Sberbank Strakhovanie 36 3,7% 2,7% Soglasie 34 3,4% 1,2% Allianz 28 2,9% 1,3% Source: Central Bank of Russia. 2 Source: 3 Source: 16 Ongoing change: the Russian insurance market survey

17 The following events stand out in 2014 as affecting the structure of Russia s Top-10 insurance companies: the rapid increase in Sberbank-Strakhovanie s market share, placing it among the leaders; the decrease in market share belonging to Allianz, due to Allianz curtailing its retail business in Russia. Despite forecasts for premium growth from last year for the Top-11 to Top-20 segment which did not materialise in 2014, in the short-term insurers are still not anticipating any decreases in revenue in this segment. Expected increase in gross written premium in 2015 per market segment Our respondents believe that the market leaders will increase their share of gross written premium at the expense of smaller companies. Participants responses Expected growth for 2015 Expected growth for 2014 Actual growth in % 10% Top-10 50% +8% +7% +13% 30% 9% 9% 27% 9% Top-11 to Top-20 +1% +5% 4% 45% 9% 45% Outside the Top-20 27% 7% +2% +8% 18% More than 10% 5% to 10% 0% to 5% 5% to 0% 10% to 5% Less than 10% Note: Percentages may not add up to 100% due to rounding. June

20 Gross written premium growth dynamics per line (RUB bln) CAGR for 2 years Casco % Property % VMI % 109 Life % 53 Accident % 75 Liability (other than CMTPL) % Source: Central Bank of Russia, KPMG analysis. The growth rate for Casco premium insurance appeared to decrease more significantly than expected, with growth in 2014 limited to 3%. This slowdown is attributed to a general decrease in purchasing power, causing a 10% 4 fall in car sales in In 2015, the decrease in car sales is expected to continue, with the Association of European Business estimating that it could reach 24% 5. In 2015, insurers forecast a 1% decrease in Casco gross written premium. 4,5 Source: Association of European Business news/?element_id= &sphrase_id= Ongoing change: the Russian insurance market survey

21 Expected premium growth in 2015 per segment Participants responses 9% 36% 9% Non-life insurance market 45% Insurers are anticipating further slowdown in non-life market growth from 7% to 4% in the short-run. Participants responses Expected growth for 2015 Expected growth for 2014 Actual growth in 2014 Participants responses Expected growth for 2015 Expected growth for 2014 Actual growth in 2014 Casco Property 10% 20% 9% 9% 20% 1% +6% +3% 27% +1% +3% +11% 10% 40% 55% CMTPL Accident 10% 10% +13% * +12% 18% 18% 9% 18% 1% +9% +2% 80% 18% 18% VMI Liability (other than CMTPL) 10% 10% 20% 20% 20% 20% 20% +2% +5% +8% 20% 5% +4% +14% 40% 20% More than 10% 10% to 15% 5% to 10% 0% to 5% 5% to 0% 10% to 5% Less than 10% Note: Percentages may not add up to 100% due to rounding. * While calculating the average expected growth rate we used the average rate of 17.5% for the interval More than 15%. However, the majority of respondents answered More than 15%, thus, the actual growth rate in respect of this line of business could appear to be higher. June

22 Revenue is still expected to grow, primarily originating in CMTPL sales. CMTPL sales could increase to 13% (refer to * on the graph on page 21), as predicted by our survey respondents. The reason for this growth is believed to be the revision of tariff rates that took place in The insurance executives surveyed forecast that growth in accident insurance would slow down in 2014 faster than the market s general rate of growth. This resulted in the share of accident insurance decreasing; something which happened for the first time since This was most likely caused by consumers reducing their insurance expenses a common consumer reaction as well as a 2% decrease in bank lending 6. The insurance trend for accident insurance likely indicates market saturation, something predicted by our survey participants at the beginning of Now our respondents anticipate a 1% decrease in accident insurance premiums in Liability insurance and VMI both saw premium growth exceed the expectations expressed at the beginning of Property insurance is another in demand line of business in the crisis. In 2014, premiums from property insurance grew 11%, leading to its market share increasing to 26%, approaching the level of Casco s market share. The main reason for this growth was the effective purchase by some large companies of property insurance policies. In addition to this, some smaller companies have expanded into writing premiums to cover agricultural insurance. However, our respondents do not foresee any long-term rise in property insurance and expect premium growth to slow to 1% in the coming years. Despite significant growth in the liability insurance sector throughout 2014, our survey participants predict that the number of premiums being written will decrease by up to 5% in the near future. One of the possible reasons for this could be that insurance expenses have been excluded from the budgets of government construction and infrastructure projects, as part of government cost cutting programmes. 6 Source: Central Bank of Russia 7 New reality: the Russian insurance market survey, KPMG Ongoing change: the Russian insurance market survey

23 In contrast to previous years, the life insurance market has slowed down twice as fast in terms of the amount of premium written; however, growth is still double-digit. There is no doubt that one of the key reasons for this growth is the dramatic increase in Sberbank Strakhovanie sales. The long-term nature of revenue flows in respect of this line of business should also be taken into account, as it grades the volatility of premiums according to annual fluctuations in the number of policies sold. As before, a key factor shaping the life insurance market is the decreasing amount of bank lending. The decrease in purchasing power has intensified its influence on the market, showing the prevalence of credit life insurance products on the Russian market. Our respondents additionally highlighted that reforming the pensions system could also shape the life insurance market. Life insurance market drivers Decrease in purchasing power 36% 80% Decrease in bank lending 70% 73% Economic recession 50% 55% Legislative changes (for example, reform of the pension system)* 30% New products development Investment appeal of life insurance products due to Rouble exchange rate reduction* Tax deductions for corporate clients 20% 18% 20% 10% 18% * This option was first presented in the 2015 questionnaire. June

24 Outlook for the life insurance market growth in the short term perspective Participants responses 33% 11% 11% 11% 11% 22% Note: Percentages may not add up to 100% due to rounding. More than 15% 10% to 15% 5% to 10% 0% to 5% 5% to 0% 10% to 5% Less than 10% The contradictory forces in the developing life insurance market, such as decreasing bank lending on the one hand and continuous double-digit growth on the other, could lead to different development scenarios emerging in the near-term future. The majority of survey participants forecast that the rate of growth in the life insurance market would fall by more than two-times. However, 44% of respondents predicted a 5% decrease in the amount of premium written, while the other 56% of respondents are more optimistic, expecting market growth of about 6%. 24 Ongoing change: the Russian insurance market survey

25 Preferred investment policies in 2015 Deposits 8% 25% 67% Bills 20% 80% Government bonds 25% 75% Corporate bonds 43% 43% 14% Shares and mutual funds 60% 40% Property 17% 67% 17% Derivatives 20% 80% Forex 71% 29% Less Same More Note: Percentages may not add up to 100% due to rounding. The unstable economic situation, combined with increased market and currency risk, are leading insurers to focus their investment policies away from shares and corporate bonds and towards deposits. For other securities, insurance firms are holding on to their current investment strategies. June

28 In 2015, the motor insurance market is again expected to be difficult. Our survey indicates that voluntary motor insurance is vulnerable to foreign exchange market fluctuations. Our respondents agreed that Casco is likely to be affected by volatile currency exchange rates more than other lines of business, and thus an increase in the loss ratio in voluntary motor insurance is expected. Despite CMTPL continuing to be one of the least profitable lines of business, there are no predictions for a significant increase in loss ratios. The average expected loss ratio for compulsory motor insurance is expected to remain at 2014 levels. This is most likely attributable to insurance rates being revised, the implementation of the unified methodology to determine recovery expenses (hereinafter, the unified methodology ), and the compulsory requirement for prior notice to be given to insurance companies. The actions listed above were issued by the regulator and intend to improve the position of insurers operating in this line of business. It is crucial to understand that innovation is inevitably followed by stronger regulatory control, and insurance companies are likely to be unable to optimise their geographical structures, but instead be forced to include undesirable and potentially unprofitable regions and segments in their portfolios. If they do not meet the regulator s requirements, their licences could be restricted. 75% of our survey respondents believe that the steps taken by the regulator are insufficient to prevent the impact of currency market volatility affecting compulsory motor insurance, making this market vulnerable to the influence of exchange rate fluctuations. The worsening of expected VMI losses is in line with macroeconomic trends in Russia. Statistics show that, during crises, people often turn more frequently to medical facilities, causing an increase in the number of VMI claims. Moreover, the value of medical consumables is highly exposed to the rate of inflation and exchange rate fluctuations. Both of these factors negatively influence the VMI loss ratio. This corresponds with the expectations of our survey respondents: a quarter consider that the VMI loss ratio will exceed 90%; previously, no one believed it would reach this level. Property insurance and accident insurance remain the best lines of business in terms of combined loss ratios. Yet despite there being untapped potential in these areas to increase profitability, most insurers have no plans to increase their business activities in them. 28 Ongoing change: the Russian insurance market survey

29 The loss ratio forecast for liability insurance worsened: 11% of respondents anticipate loss ratios to exceed 70%, whereas last year no one expected it would be possible to reach this level. In 2014, most survey participants foresaw the loss ratio as being lower than 50%. Average expected combined loss ratio in 2015 CMTPL Participants responses Expected CLR in 2015 Expected CLR in 2014 Property Participants responses Expected CLR in 2015 Expected CLR in % 50% 33% 100% 102% 88% 90% 67% Casco Accident 25% 11% 108% 103% 86% 88% 75% 89% VMI Liability (other than CMTPL) 100% 63% 38% 100% 100% 85% 88% More than 110% 100% to 110% 90% to 100% Less than 90% Note: Percentages may not add up to 100% due to rounding. June

30 Despite increases in the CMTPL and VMI loss ratios, the combined loss ratios for these lines of business remained at the same level as in The expected combined loss ratios for all lines of business, except Casco, have not changed significantly when compared to the previous year s forecast. This suggests that the cost cutting programmes rolled out by insurers at the beginning of 2014 were effective. The profitability of Casco insurance is likely to decrease to a greater degree when compared with other lines of business. This is attributed to the overall macroeconomic situation and the influence of exchange rate fluctuations. These factors mean that nothing could have held combined loss ratio for voluntary motor insurance at the previous level neither regular revision of rates nor the extensive use of cost cutting procedures carried out by the majority of insurers in The results of this survey suggest that a quarter of respondents consider that the combined loss ratio for Casco may exceed 110%. Preferred methods to reduce claim costs Optimise business relationships Expand underwriting analysis and make corresponding changes in products* Toughen anti-fraud management Enhance litigation processes (especially in relation to motor claims) 9% 33% 75% 64% 75% 58% 45% Optimisation of business relationships remains key to reducing claim costs. 33% Increase subrogation collection ratio 27% 25% Change pricing 25% Wider use of deductibles 36% 25% Exchange claim data with other insurers 18% Optimise the regional portfolio structure* 17% % In order to keep their businesses profitable, insurance executives are looking at improving their business relationships, increasing the strength of their underwriting analysis via the inclusion of additional risk factors, and revising the conditions attached to existing products to adapt them to the current market. In contrast to 2014 s plans, insurers are not planning to adjust loss ratios on their portfolios by increasing rates. The current levels are likely to reach their ceiling, with further raises in tariffs deemed inefficient. * This option was first presented in the 2015 questionnaire. 30 Ongoing change: the Russian insurance market survey

31 Preferred methods to cut administrative costs Decrease or cancel salary indexations 36% 67% Optimise organisational structure 58% 73% Decrease rent costs 18% 58% Introduce new organisational models 42% 45% Share services 25% 55% Reduce headcount 25% 45% No further reduction of the above costs 8% 18% Insurance executives are seeking to cut administration costs mainly by cancelling or decreasing salary indexations. In addition to this, more than half of respondents singled out the renewing of rent contracts under fixed Rouble exchange rates and optimising internal organisational structures as the preferred methods to cut administrative costs. Insurers no longer consider headcount reductions as the only way to reduce administrative expenses. In 2015 they are going to focus on protecting the resources they have, including human ones. June

32 Preferred methods to cut acquisition costs Optimise relationships with intermediaries and partners 55% 75% Develop Internet/phone sales 75% 82% Increase the number of contracts that are prolonged 58% 55% Develop cross-selling* 33% Develop direct sales 8% 45% Optimise regional portfolio structure* 8% * This option was first presented in the 2015 questionnaire. Most survey respondents aim to continue optimising relationships with intermediaries and partners in order to lessen the burden of acquisition costs. As last year, insurance chief executives have great expectations that, via the development of internet sales, initial sale costs can be practically reduced. 32 Ongoing change: the Russian insurance market survey

35 The main external factors affecting the motor insurance market are: Changes to the laws governing CMTPL insurance The introduction of a unified methodology to estimate CMTPL losses The decrease in the Rouble exchange rate Expected increases in CMTPL rates in order to correspond to the loss ratio Participants responses 14% 10% to 30% increase 14% Less than 10% increase No change, rates are sufficient 71% Note: Percentages may not add up to 100% due to rounding. The following changes to obligatory motor insurance legislation were recently implemented: increase in tariffs (to 23% in October 2014, and further to 40% in April 2015); rise in coverage limits (from RUB120,000 to RUB400,000 for property, and from RUB160,000 to RUB500,000 for health and life); extended acceptable tariff ranges (from 5% to 20%). The market leaders are setting prices at the maximum end of the scale in order to cope better with the high loss ratios associated with this line of business. However, more than 70% of our respondents believe that CMTPL rates are still not high enough to be able to cover expected insurance payouts, and suggest an additional increase of 10% 30%. Moreover, taking into consideration recent events, insurers are expecting more oversight of policy sales in Russia s regions. In the opinion of our respondents, this could lead to loss ratios increasing further, making the current tariff rates insufficient. Moreover, the coverage limit for Euro-protocol claims was increased in the Moscow and Saint Petersburg regions (along with general coverage, it was increased to RUB400,000). It can be concluded that 40% of our respondents are expecting a significant increase in fraudulent claims in these regions. June

36 Insurers are paying additional attention to the financial result of CMTPL direct claim settlements. The Belgian system applied at the beginning of 2014 prevents insurance companies from selecting claims. 67% of our respondents confirmed that the financial result of the direct claims settlement is close to zero (meaning that the company s payouts are virtually the same as the reimbursements it has received from the special account in Russian Union of Motor Insurers). However, 17% of those surveyed declared that their payouts are higher than the reimbursements they receive, and that loss adjustment expenses are not the only reason for this mismatch. About 60% of respondents think that the direct settling of claims has done nothing to really help overcome fraud, stating that 30% of the claims reported are still illegal. The share of fraudulent claims in those settled under the Consumer Protection Law since the prior notice to the insurance company condition was introduced Participants responses Average share of fraudulent claims in 2015 Average share of fraudulent claims in % 29% 23.7% 29.0% 57% 30% to 50% 10% to 30% Less than 10% 36 Ongoing change: the Russian insurance market survey

37 In December 2014, insurance companies started estimating CMTPL claims via use of the new methodology demanded in law. Before this law, there was no unified methodological system and companies estimated claim amounts based on the opinions of experts. Insurers have been positive about these changes; however, more recently, some car owners have experienced problems (luxury foreign car owners in particular) because the cost of standard hours and spare parts calculated under the unified methodology is lower than the actual recovery expenses estimated on the basis of the real prices of official motor dealerships. However, the insurance companies believe that this system, used to estimate CMTPL claims, will soon be stabilised (prices will be revised twice a year), meaning that actual expenses will be in line with those provided by the unified methodology. Possible measures to decrease the burden of inflation on motor insurance caused by the fall in Rouble exchange rate Hedge exchange rate risk 57% Increase rates for foreign-made cars 57% Renew contracts with intermediaries under a fixed Rouble exchange rate 29% Increase the number of repaired parts vis-a-vis replaced parts 14% At the end of 2014, the problem of currency exchange rate fluctuations was being widely discussed by insurance market analysts. Spare part prices and lacquer car paint coatings for foreign-made cars are highly influenced by exchange rate fluctuations. As such, this influences motor insurance loss ratios. Insurance executives consider hedging against currency risks and adjusting rates for foreign-made cars are both equally important measures in the fight to help insurers compensate inflationary pressure. In addition to the above, writing specific conditions (such as fixed currency exchange rates and discounts) into contracts with service stations may help hold repair expenses at previous levels. June

39 The influence of fraud on the performance of insurance companies remains significant. When all the other methods used to improve profitability have been exhausted, it will be the insurance executive who pays attention to fraud levels who discovers potential to increase profitability in this area. The share of internal and external fraud in a company s gross written premium Participants responses 45% 9% 20% 20% Internal 45% External 20% 40% 15% to 20% 10% to 15% 5% to 10% 0% to 5% 0% Note: Percentages may not add up to 100% due to rounding. Insurance companies could be underestimating the impact of fraud on their performance results. All of the respondents noted the effect of fraud on the financial indicators of their insurance companies. However, only half of survey participants had given consideration to the thought that fraud might not only be caused by external forces, but could also by caused by internal corporate malpractice (an insurance companies own staff cheating). June

40 The share of fraudulent claims in each market segment Casco CMTPL VMI Property Participants responses 20% 40% 40% 60% 40% 80% 20% 63% 13% 25% 15% to 30% 5% to 15% Less than 5% Note: Percentages may not add up to 100% due to rounding. Our survey respondents estimate of the percentage of claims that are fraudulent is slightly lower than similar estimates from leading Western markets 8. The results of this survey suggest there is a belief that, even in lines of business such as VMI and Casco which are notoriously liable to fraud the number of fraudulent claims being made is rather low. Respondents expressed the opinion that the share of fraudulent claims in VMI is not above 5%, while the average amount of fraudulent claims for Casco is 13.5%, with the corresponding property insurance amount being 7%. 8 Insurance information institute Association of Certified Fraud Examiners aspx?id= , Global Health Care Anti-Fraud Network newsroom.html 40 Ongoing change: the Russian insurance market survey

41 Areas that are primary fraud targets Claims settlement Procurement (including third party services) Abandons disposal Underwriting/ faulty tariffing Commission payments 18% 9% 9% 9% 91% The majority of respondents highlighted the settling of claims as the area most exposed to fraud in the performance of their insurance company. June

42 Among the other problem areas our survey respondents highlighted were procurement, underwriting, commission payments, and abandons disposal. However, the possibility for third parties to swindle the companies out of money in these spheres is still significantly lower than when settling claims. Interestingly, insurance executives share the view that fraud in these areas does not significantly influence the profitability of their companies, affecting only on average about 2% of a company s revenue. It is no surprise, given that our respondents consider motor insurance as the line of business most liable to fraud, and the settling of claims as the area of performance most affected by the work of fraudsters, that the department of motor vehicles / traffic control officials, appraising officers, and vehicle service station employees were those identified as being most connected with corruption. Third parties often involved in insurance fraud Appraising officers Department of motor vehicles and traffic control officials Vehicle service stations employees Medical institutions Fire-fighters 13% 38% 63% 75% 75% Insurers may be concentrating only on external fraud while underestimating their own internal corporate fraud. 42 Ongoing change: the Russian insurance market survey

43 Preferred measures to decrease fraud Integration of automated instruments of control in company s IT system 75% Monitoring loss ratios per agent on quarter basis 58% Segregation of duties 50% Information exchange with other insurance companies and law enforcement agencies 50% Training staff and intermediaries on fraud counteraction 42% Centralisation of main functions 42% Expansion of internal security service 33% Implementation of KPI system for agents 33% Creation of special department responsible for internal inquiry on fraudulent cases 33% Creation of feedback mechanism (such as Hot line ) for potential fraud cases reporting 17% Harsher punishments for fraudsters 8% Profile examination of candidates during recruiting procedures 8% Implementation of decreasing factors for calculating commission 8% Survey respondents considered feedback mechanisms (hot lines) as one of the least effective way to fight fraud. One of the best methods preferred in the struggle against fraud is the integration of automated control instruments and quarterly monitoring of loss ratios per agent. Creating feedback mechanisms (hot lines) is seen as the least effective way to reduce fraud. However, this is precisely the method highlighted by the Association of Certified Fraud Examiners 9 as the most effective instrument in revealing internal corporate fraud. 9 Source: June

45 The effect of in-force and forthcoming changes to the insurance market Participants responses 8% 17% 25% 50% Changes are insufficient and inefficient Changes are effective; however, there are still areas needing improvement Changes significantly increased regulatory pressure Difficult to say Note: Percentages may not add up to 100% due to rounding. Half of our survey participants consider that regulatory changes have led to a strengthening of regulatory pressure on the insurance business, as recent insurance market news has confirmed. The recently-introduced regulatory changes were intended for CMTPL. Yet 25% of our respondents consider that the insurance market still has some areas in need of effective supervisory control, the other 17% consider that in-force changes are insufficient and inefficient. June

47 Economical validity of the current capital requirements Participants responses A third of our respondents consider the current capital requirements to be economically ungrounded. 33% 67% Yes No Insurers see three possible solutions to this problem: change solvency margin calculations; allow for companies to have their own internal capital models; or switch over to foreign practices, such as Solvency II. When dealing with morle specific problems, the tendency is to cut personnel costs and reduce commission, actions which correspond with the desire expressed by insurers to further develop their online sales. Most respondents (about 60%) are waiting for the final amendments to the law On the organisation of the insurance business in the Russian Federation, which would enable compulsory insurance policies to be sold via the internet (currently only voluntary insurance policies are sold online). Direct sales would permit insurance companies to cut agent and broker costs. The option of buying CMTPL policies online should be possible in 2016, according to the Central Bank of Russia. However, insurers will need time to adapt Possible changes that could have a positive influence on the capital requirement level Allow companies own Internal capital model Switch to foreign practices (for example, Solvency II) Change solvency margin calculation (Federal Law No. 90n) Change asset allocation rules Introduce new types of risk (market, operational, liquidity) to this sales channel, as 60% of respondents fear that the online sale of CMTPL policies could lead to incorrect information being submitted, which in turn could lead to loss ratios for this line of business being negatively affected. Nevertheless, our 25% 33% 42% 50% 58% respondents believe that internet sales will enable them to cut acquisition costs, once they have learned to manage the sales. As such, this is a priority area for them. Problems such as fraud and fighting claims in court, are expected to remain crucial for insurance companies in % of our respondents highlighted this as an area requiring supervision and control from the mega-regulator. June

49 Likely M&A activity in Sale of one or more large Russian insurance companies 50% A large insurance company s licence being revoked 42% Foreign companies leaving the market M&A activity among Top Russian companies None of the above 25% 25% 25% According to our respondents, in 2015 market consolidation could accelerate due to a large insurance company being sold or licences being revoked. Increase in the Top-10 s market share in 2015 Participants responses 9% 45% More than 5% 2% to 5% 45% 0% to 2% Note: Percentages may not add up to 100% due to rounding. June

50 The percentage of insurance companies close to bankruptcy/licence revocation per segment 38% 50% Participants responses Top-10 Top-11 to Top-30 13% 50% 50% Average expected percentage in 2015 Average expected percentage in % 13.5% 21.3% 18.7% Our respondents expect that the percentage of companies close to bankruptcy or having their licences revoked will increase for each market segment. This can be attributed to a number of factors, such as the general macroeconomic environment in Russia, the fall in the Rouble exchange rate, sanctions, the strengthening of regulatory pressure, and the stock market fall at the end of Macroeconomic difficulties affect smaller market players more than larger ones, as they do not have enough resources to maintain their own financial stability and survive the difficult times without additional capital inflows. This means that the leaders have the opportunity to strengthen their market position and capture additional market segments. Our respondents expect this: 45% anticipate that the market share of the Top-10 will increase more than 5%. The leaders could also expand their portfolios as a consequence of foreign companies curtailing their retail businesses and leaving the market. 25% 38% Top-31 to Top % 23.7% 38% More than 40% 20% to 40% 5% to 20% Less than 5% Note: Percentages may not add up to 100% due to rounding. 50 Ongoing change: the Russian insurance market survey

51 June

52 Contacts Adrian Quinton CIS Head of Insurance and Actuarial services Partner T: + 7 (495) E: Alexey Nazarov Strategy and Operations Director T: +7 (495) E: Andrey Voronin Actuarial services Manager T: + 7 (495) E: Sofia Ievenko Forensic Director Т: +7 (495) E: John Kallaway Corporate finance Partner Т: +7 (495) E: Mikhail Klementiev Tax and Legal Partner Т: +7 (495) E: Julia Temkina Deal Advisory Partner Т: +7 (495) E: The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation JSC KPMG, a company incorporated under the Laws of the Russian Federation, a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International.

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